Various systems exist which assisted in the formulation and submission of securities trading transactions to liquidity destinations, otherwise known as Pre-Trade Systems, collected and processed information related to consummated transactions after the close of the securities market each day, otherwise known as Post Market Systems, and enabled risk and portfolio risk modeling and analysis after the close of the securities market each day, otherwise known as Post Market Analysis Systems. An overview of the trading market is illustrated in FIG. 4. In addition, systems exist that supported intraday risk analysis and modeling but only for those transactions processed through, or integrated with, such systems, otherwise known as Intraday Closed Systems.
The popularity of disparate trading systems, Delivery versus Payment (DVP) or Receipt versus Payment (RVP) transactions and multiple prime brokerage relationships creates a situation where intraday risk exposure from large volume, large dollar U.S. equity transactions is not properly managed by existing Pre-Trade Systems, Intraday Closed Systems, Post Market Systems or Post Market Analysis Systems. These systems fail to address the significant losses that can result from delayed response to intraday risk exposure.
The effectiveness of pre-trade risk management in existing trading systems has been severely limited by the growing use of multiple trading systems by institutional investors to access common pools of capital to affect sophisticated investment strategies. These disparate systems have been limited to managing risks associated with internal transaction flow. Therefore, a consolidated view of risk could only be possible only on a retrospective basis (e.g., at day's end after the close of the market) when information from disparate systems could be collected and analyzed.
Institutional clients often use brokers to execute transactions involving financial articles of trade that are physically held and cleared by another broker or custodial bank, via Delivery versus Payment (DVP) or Receipt versus Payment (RVP) transactions. Risk management systems used by executing brokers are generally unable to manage risks associated with these transactions, because they are not integrated with the risk management systems of other potentially involved executing brokers and/or with one or more risk management systems of one or more relevant custodians. As a result, risks associated with such transactions may only be evident until well after their execution.
The prime brokerage landscape (i.e., investment banks providing global custody (including clearing, custody, and asset servicing), securities lending, financing (to facilitate leveraging of client assets to enable investment of greater amounts than actually on deposit), capital introduction, and similar services to hedge funds, proprietary trading groups and other professional trading entities) has changed dramatically since the collapse of Lehman Brothers in 2008. Trading entities that received credit (a.k.a. “margin”) financing from Lehman Brothers could not withdraw their collateral when Lehman declared bankruptcy due to lack of adequate asset protection rules.
As a result of Lehman's collapse, trading entities realized that no prime broker was too big to fail. Sophisticated trading entities desire to spread their counterparty risk across several prime brokerages and, in order to attract and retain their business, prime brokers support such multi-prime broker relationships.
Trading entities take advantage of prime brokerage service offerings, as well as the capital strength and reserves, of numerous prime brokerage firms by executing transactions with multiple prime brokers. That is, one trading entity may have relationships with more than one prime broker. In a way, this distributed relationship with multiple prime brokers increases the trading entity's opportunity to make trades throughout the market.
However, the distributed relationship with multiple prime brokers also increases the exposure to the trading entity as well as prime brokers who have extended credit and/or act as guarantor(s) of the trades. For example, a trading entity may elect to conduct “away” trades with a willing prime broker (for purposes hereof, referred to as the “executing broker”). In these cases, details regarding the assets and credit arrangements underlying a trade are not known by the executing broker making the trade, and while details regarding assets and credit arrangements are known by the prime broker (for purposes hereof, referred to as the “custodial broker”) who has custody of such assets and/or has established credit arrangements with the trading entity making the trade, details regarding the trade itself are not known by the custodial broker. The details of the trade are actually held by another prime broker, the executing broker. Since the away trades are not executed by the custodial prime broker, information about those trades are hidden from the custodial prime broker until well after their execution, potentially putting the assets and extended credit associated with the trading entity at risk. The risk may be increased when the trading entity makes multiple away trades with multiple, non-custodial prime brokers. None of these non-custodial prime brokers are aware of the away trades conducted by other prime brokers, and the custodial prime broker is not aware of any of these away trades, until a later time, thereby further increasing the exposure of the trading entity and the custodial prime broker.
Hedge funds and other institutional investors increasingly participate in “away” trades. This means that the trade was done by an executing broker other than the client's clearing firm or prime broker on an agency basis (e.g., securities were bought and sold directly into or out of the client's account) or on a riskless principle basis (the executing broker executes the trade after receiving an order from the investor and then allocates the trade to the investor's account with a markup/markdown or commission. In both situations, the trade is done using an identifier (generally known in the industry as a “Neumonic” or “MPID”) that is different than the investor's identifier but is subsequently allocated to that investor for clearing at the investor's clearing firm. In addition, hedge funds and other institutional investors enter into multiple clearing arrangements with clearing firms or prime brokers. In this situation, the investor may have funds on deposit at each firm and each firm actually clears his transactions or he may have a DVP/RVP relationship with one or more of the firms where the trades are transferred (generally referred to in the industry as “given up”) to the firm that will actually do the clearing of the transaction. In all of the above situations, risks associated with transactions may only be evident until well after execution of those transactions, such as after close of the trading day.
Accordingly, trading entities often take advantage of brokerage service offerings, as well as the capital strength and reserves, of numerous brokerage firms by executing transactions with multiple brokers. That is, one trading entity may have relationships with more than one broker in order to take advantage of efficiencies in reaching the market and other proprietary access or information available to one broker over other brokers. In a way, this distributed relationship with multiple brokers increases the trading entity's opportunity to make trades throughout the market.
However, in some cases, distributed trading can adversely affect the market. For instance, a trading entity places multiple trades using more than one broker and possibly overextending its capital reserves backing the trades. If the trading entity fails to make good on a trade (i.e., the trade “fails”), it not only jeopardizes the trading entity's financial position if it cannot cover the trade, but could also jeopardize the entire market if that trade was sufficiently large, or if multiple trading entities are in the same overextended position, thereby multiplying their effect across the entire market.
Further, the problems with distributed trading can be amplified when considering that there are multiple trading entities, multiple brokers, multiple trading systems, and multiple markets through which trades are made. As such, a trading entity may make trades using one or more brokers, over one or more trading systems, on one or more markets. Since all of these different segments of the market do not necessarily communicate with each other, actions by one party in one segment can adversely affect other parties in other segments, such as when one or more trading entities are badly overextended.